Don’t Be the Emperor With No Emergency Fund

Before we start, minions: Today’s post features a word beginning with “S” AND a reference to horses and pornography. If that bothers you, it might be a good day to check out this website instead.

We all know the old story: emperor surrounds himself with yes men. His posse tells him he’s awesome. Some dude comes along to rip him off and tells him that he’s designing clothes only super brilliant people can see. Emperor is shocked he can’t see the new threads, so he pretends like he can. His homies, not wanting to look stupid, all say “great clothes, dude!” while their favorite ruler runs around buck-naked.

Don’t be that guy.

Two blogs I respect ran pieces about how emergency funds are overrated. While I can see portions of their point, you should think closely before following any advice to ditch your emergency fund.

Sure, interest rates are low and you can garner higher returns elsewhere. Big deal. My life isn’t about squeezing another $10 out of my $5k emergency fund. I’m not staying up at night thinking about how those $%#!ing nickels in my piggy bank are earning 0% when they could be cashing in on October hog futures. (that’s not an endorsement of October hog futures)

No, my life is about avoiding the worry around what the hell I’m gonna do when I’m dragging my muffler behind the car.

I know what I’m gonna do. I’ll attack my fund. I also might just float it on a credit card because it isn’t a big deal.

Then I worry about, “what if I lose my job?”

Hmm…..

What an emergency fund accomplishes is nothing short of amazing. A few thousand dollars in the bank can:

– ensure you don’t have to worry when shit hits the fan (and it will…you KNOW it will!).

– allow you to pay off your credit card without stopping the plan (the reserve covers all your emergencies along the way).

– lets you take that hog futures flier with your investment portfolio without having to take your money out before you reach the right time to pull the trigger and giggle all the way to the bank.

The first two points won’t stop the snoring sound from non-believers. Only the last point: investing without having to take the money out, commands the attention of emergency-fund naysayers.

And now, minions, Uncle Joe’s Story Time

Let’s say Sally decides that the #5 horse in race three is the perfect investment for her money. Screw the emergency fund. Sally wants the big cash payout, not a few Abe Lincolns. Those are for suckers. The race starts and JUST THEN she gets a call from her boss.

“Hey, Sally? We found that porn on your computer. You’re fired.”

The #5 horse is in the middle of the pack. It might win or it might lose. But Sally doesn’t have time to care. She has a mortgage, utility bills, groceries to buy, and it’s all now riding on the #5 horse. She needs that money out of the race NOW!

Oh boy. Sally’s got a problem, and not just with horses and porn…she’s got severe money issues.

Now, if Sally had an emergency reserve, she could have bet the farm on the #5 horse and watched the race in harmony. Sure, she still has some social problems and maybe a gambling habit, but her reserve will carry the day.

Now, you aren’t Sally, you don’t have those issues, and your #5 horse is called a Roth IRA. I hope you understand my parable: where are you going to go for money if you lose your job?

Probably breaking the Roth.

An emergency fund isn’t about the little bit of money in the fund. It’s about the HUGE gains you can make on the money outside the fund if you DON’T HAVE TO TAKE IT OUT AT THE WRONG TIME. Do you want to be a great investor? IF so, here’s your ticket to greatness: Don’t need your money early.

Why “No Emergency Fund” Won’t Fly

Sometimes things sound like a great idea. Clothing that only smart people can see. However, in practice, when you meet hundreds of families, you begin to see all the outliers that might happen out there.

“Oh, Joe, that’ll never happen to me!”

Maybe not. But that’s why people paid me good money…and thanked me when life happened to their goals. People did lose their jobs. Because they had an emergency fund they were able to:

– Eat

– Sleep

– Start a new business

– Build contacts by going to lunch and networking events

– Keep a car to go to interviews

Call me crazy, but when bad stuff happens, I don’t want to have to touch my investments AND I want to be able to do those things.

Worse yet, on one of the two sites (of course, the uber-popular one), the author points to having good credit as a way of avoiding the need for a large emergency fund.

Huh? Let’s think this through:

Let’s say I lost my job. How much does good credit help me? How am I going to make the payments on my debt while I look for another job?

I’ve written before about having nearly no income for twelve months. My good credit at the beginning was shot. If I’d had a six month reserve, I might have been able to squeeze through….I’m not buying the “good credit” argument.

I’m Not Ripping Other Bloggers

This isn’t meant to rip the two bloggers who wrote on the other side of this topic. Both of those guys know that I have huge respect for their blogs and love their work. I’ll keep reading their advice, because they’re real people with knowledgeable and well researched opinions. If you know who I’m referring to in this post, you should keep reading their blogs, too.

On this issue, though, I think that my public needs to hear my point of view on this subject, and it definitely is on the other side of the fence.

Comments

When we first got serious about our finances, we saved up an e-fund. It seems somewhat counterproductive to spend time saving up for an emergency fund instead of just aggressively paying down debt, but I’m so glad we did listen to Ramsey and everyone else! We’ve needed to use a bit of it already when Jeff turned into the Hulk on the outside faucet last month.

I understand your point and I think in most circumstances, an emergency fund is a very, very good idea. Here in the UK we have ISA’s (Individual Savings Accounts) which are similar to a Roth IRA in that you can put a certain amount of money in a tax-free “wrapper” each year. These can be ideal for emergency funds because you don’t pay tax on them, they earn interest, and if you choose the right ones, you can get the money out penalty free if the horse muck hits the fan!

The main situation in which an emergency fund is overrated, for me, is when you already have a huge amount of personal debt weighing you down. In general, the money you earn in interest on that savings fund is far lower than the interest you are paying out on your debts.

Using your fund to pay off debt is a great way to reduce your burden and improve cash flow. If the muck DOES hit the fan, well you can use the line of credit you cleared with the fund to fix it. You’ll be no better or worse off — but the probability of a massive expense is far lower than not.

Thanks for the comment, Ian, and I see your point. I agree with your ISA use for an emergency fund. In the USA, I’ve recommended a similar approach using a Roth IRA.

On the massive debt side, that’s the Catch 22 I’ve seen people work through before: you forget the emergency fund (waste of time and interest) and focus on the debt. You get it NEARLY paid down and then your washing machine breaks down. Where do you go for money? …right back into debt. Sadly, I’ve seen people do this over and over for 20-30 years before they’ve gotten it together. Graphically, it looks like a saw: lots of debt/paid nearly up/lots of debt/paid nearly up/lots of debt/paid nearly up….

In my view, you have two choices: 1) make sure nothing bad happens while you’re paying down debt (ain’t gonna happen); or 2) realize real life, including bad stuff, is going to happen, and keep a reserve in place to handle that so you can pay down your debt uninterrupted. Over and over, this worked like a charm with clients.

So, I’m with you, Ian…doesn’t make sense logically when you think about wasted interest….but if you think about time and the fact that life continues to throw bad things our way, it’s the way to go.

I tend to agree with you. I read the other articles and while I’m happy for them that they’re on a point in their financial journey that they feel they have the freedom to do that, I just don’t know if I’d ever be comfortable. I’m a worrier. And I’d like my emergency funds to be as liquid as possible.

That’s funny, FF. Most of my clients were worriers, too. They would never take a chance with a dime unless the emergency fund was intact. Did I mention I worked with highly successful people? I think they had good habits.

Emergency funds are just that for emergencies. When you have piles o’ cash lying about emergencies turn into annoyances that you planned for. I plan on keeping my clothes on for a long long time. Thanks uncle Joe!

Having an emergency fund is crucial for my family to stay on budget and for my personal peace of mind. If something breaks, I fix it. If something needs replaced, I write a check for it. I cannot imagine not having a fund for emergencies!!!

Great, Joe, now you’ve got me all worried. I have a mere $1000 in my emergency fund and put everything else on horses #1 and 2. Should I reign in my fast-track-debt repayment grand plan in order to put another $1000 in the kitty?

Ah! I’m with Mr. Ramsey on this one (not with him all the time, but agree on this). $1k reserve is perfect for 90% of the emergencies you’ll face. You’re so close to done now, finish it up, then finish paying your debt. If you’re REALLY worried, split your payments (50 extra to debt/50 extra to reserve). It doesn’t have to be one or the other.

I pretty much said the same thing when I saw one of those two posts. It doesn’t work for me but other people can do what they want. Hopefully it doesn’t come back to bite them but I agree more with your side of the story. I like my clothes I can see 🙂

Great article Joe. I wan’t too articulate with my viewpoint. I do believe in having an emergency fund, but having excess chunk of cash — due to fear of the armageddon — requires another thought. Also, being an immigrant who came to this great nation without any money, I know that building self-confidence is equally, or even more important, than piling up cash. Again, I am all for 5k-10k cash for emergency.

I’m 100% with you on the “money in the basement” philosophy. Absurd. Money should be in smart savings areas. As I mentioned in my comment on your post, I think people build self-confidence by having reserves. It gives them the balls to take some risks because they know they won’t have to pull funds out early. Thanks for the clarification, Shilpan!

Ian has a great point that I tried to make in my article. For those who are heavily debt ridden, having excessive cash is detrimental. Instead, focus ought to become debt free. You can always borrow(strictly in emergency) from your plastic.

Joe, fully agree with you – and a well written piece as well. It seems to me that we have all developed a bit of a ‘credit/ mentality – because so much credit is/was available to us people start think og it as ‘reserves’. Dumb, I know, but the number of time I here this…

I agree with Krant. Savings provides choices. We often try to balance debt and savings. We don’t have debt any more but when we did we still put money into savings, an ER fund and a few other accounts. We wanted to cover all basis. It worked really good for us and we were still able to pay down debt.

When a friend who had significant debt got a new, great paying job, she asked me what she should do about debt and savings. I told her that in the beginning, she should split her extra between debt and savings until she got to $1k in savings, and then everything should go toward debt. And my point was the same as yours- if something new happened, if all the money had gone toward debt, she would just have to go back into (deeper into) debt again to deal with it. Our current savings is much larger than either of us really likes, but given the forseeable expenses (adoption) it doesn’t make sense to put it somewhere where we’ll have to pay penalties to get it back.

This is also a risk includes when someone thinks about starting his/her own business because business never goes with the predictions and hence financial support should always be in founder or managers hand to give immediate backup to the company if needed.

Thanks for this wonderful article because it gave me an idea to think around this subject that matters for every entrepreneur.

Good credit will get you as far as your first missed payment. We’ve never had 8-12 months of cash sitting in a savings account, but I think you need to have enough to at least cover those unavoidable things that do pop up. BTW, thanks for your comment on my site.It was the first one I’ve gotten. I didn’t even check yesterday because I am used to none. I feel like I won a gold medal!

I like cash. As you stated, there’s nothing like getting a $700.00 car bill (yesterday) and it’s no big deal. That’s the plain joy of having an emergency fund. It’s not to get a return, it’s for peace of mind!!!!

Great points and advice. I think I know which blog posts you were referring to. I believe one of them made it clear that it works for them and may not work for other.

Two points you mentioned that really stuck out to me: – emergency fund: allow you to pay off your credit card without stopping the plan – Emergency fund: Build contacts by going to lunch and networking events

If you lose your job, being able to take advantage of the time to network with your contact or meet future contacts is incredibly advantageous.

I’ve recommended to people and in my book to try to do both: allocate money to your emergency fund and to your debt. Similar to a strong business: it will have cash reserves and continue to pay on its debt obligations.

I know exactly which two posts you are referring to. While I have my own love-hate relationship with emergency funds, I do think they have their place. I was thinking about writing my own spin on the topic. I’ve got a different strategy that I use.

You caught us in transition, Sam. The left button is for the blog, the right one is for the podcast. Those are changing and we’re having a hell of a time. The button on the left works, but only the bottom half. Not fun. It’s like the toilet handle…you’ve gotta jiggle it.

I’m with you on focus. If you’re only focus is on an emergency fund, you’re screwed. If your goal is to have a fund so you can be a more aggressive investor…fantastic.

Alright, so I’m off to the racetrack to place some bets using my emergency funds. Just kidding. Although its impossible to be fully prepared for an emergency, it gives me a peace of mind knowing I have some cushion to help break the financial fall. Love your smart humour! I love blogs that talk about finances in a funny way.

You won’t hear an argument from me. A big fat emergency fund is what has helped me get through my first 3.5 years of freelancing. Unfortunately I relied on it too much, and now I’m having to start saving up for it again. As a freelancer, I have dry months, and I need something to fall back on. In my case my emergency fund should probably have more than 3 months in it. I’d like 9-12 quite honestly.

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Disclosure

The Free Financial Advisor is not an investment advisor and the comments posted herein are opinions of the authors. While they have been professionals at one time, since AverageJoe, Emilie and others are not currently a registered investment advisors or brokers, their opinions should be considered those of amateurs.